Backtesting
Tuesday, June 11th 2019
Backtesting Calendar Spreads Based on IV Contango
Backtest a calendar when the implied volatility term structure is in your desired shape. Set the Entry Indicator Trigger to Contango.
Summary
Backtest a calendar spread based on IV contango by setting the entry indicator trigger to contango, which measures the slope of the 45 day implied volatility term structure. When contango is negative, the term structure is in backwardation, which is favorable for buying a calendar spread. By setting the max to 0 and leaving the min blank, you can run the long call calendar and compare it to a test not using contango. The SPY long call calendar had an annual return of 0.58% with contango set to max=0, compared to -0.09% without it.
You can instruct the ORATS backtester to trade a calendar only when the implied volatility term structure is in your desired shape.
The easiest way to do this is to use the Contango measurement. ORATS Contango is the slope of the 45 day implied volatility term structure. When Contango is negative, the term structure is in 'Backwardation'. Since when you buy a calendar you are buying the back month and selling the front month, you want the shape of the skew to be in your favor as much as possible, and this means you want Backwardation.
To trade only when your ticker is in Backwardation, you can set the Entry Indicator Trigger to Contango by clicking on the IV Rank drop down box and typing in contango. Set the Max = 0 and leave the Min blank as in the picture below.
Now you can run the long call calendar and compare to a test not using Contango.
I ran the SPY long call calendar with the default values and got an average annual return of -0.09%. With the Entry Indicator Triggers Contago set to Max=0, I got an annual return of 0.58%, a substantial uptick and was in the market 66% of the time.
Try it yourself. Get a free trial to the backtester HERE.
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